By Steen Jakobsen
It is no secret that my biggest trade for 2014 is significantly lower growth going into the second half of the year, by which time Asia will have adjusted growth down by 100-200 bps to help rebalance local economies. This will hurt the export machines in Europe and in the S&P 500, but, after a nice run in late 2013 and early 2014 being long fixed income (Bunds, Denmark and IEF) my model is now calling for a correction higher in interest rates.
The narrative is fairly easy to establish:
- Overconfident central banks and policymakers on growth for 2014 (the IMF and World Bank both increased growth forecasts last week).
- A technical pattern clearly showing the need for a 200-300 bps correction in the US and Europe.
- Global central policies are now at a junction, where the Bank of England (BoE) plus maybe the US will hike rates in 2014, while the Bank of Japan (BoJ) and the European Central Bank (ECB) looks almost certain to do more on downside in yields. Hedge fund Tudor Investment explored this subject yesterday morning in a research piece.
The market is priced for perfection. A slow, gradual telegraphed exit in the US, a slower-than-usual policy response from the BoE as governor Mark Carney is seen as a dove and in Europe, if needed, the ECB will do not less. The odd one out is the BOJ, where results are starting to reverse on Abenomics even before the April VAT hike, which will kill whatever growth there is created from the world's biggest monetary experiment.
Japan's economy is already running out of steam ahead of a VAT-rate hike in April. Photo: antb \ Shutterstock.com
The Stress Indicators are almost entirely trading HIGH on risk and LOW on credit spreads. It's hard to remember a more perfect pricing expectation scenario, except maybe for the "strange" resignation of co-chief investment officer Mohamed El-Erian today from the world's biggest fund manager Pimco El-Erian.
Is this one of those signs you should take not off? Is this a bullish or bearish sign for bonds? Most probably it is positive for fixed-income prices (lower yields) overall.
US YIELD CURVE starting to price in earlier Fed exit?
Comment: There will be a price to pay for the significantly higher US real rates. Our model operates with a 12 to 18-month lag, meaning the period from May to August should see dramatic growth and activity slowdown. Real rates are up 150 bps since April, measured as 10-year US generic rates minus deflator (the only real inflation gauge).
Comment: There is a small paradox — the higher US rates should in normal conditions have sent EURUSD into the lows, instead it trades on the high — why? Think "deflation risk". Europe has a more than 50:50 chance of deflation, while the US is 25:75 against. A currency with weak inflation SHALL increase in value.
Comment: Being a simple man, I use AUD versus JPY as my ultimate risk indicator. AUD is due to growth, commodities and China. JPY is due to cheap funding, manipulation and carry. It's been going absolutely nowhere or, perhaps more correctly sideways since August 2013, indicating that stock and risk are going up on chasing returns.
Comment: The target for my correction is probably a test of the high channel in 30-year US rates based on hope, feel good and naivety on 2014... It's January; everything can happen!
Comment: The stock market remains bullish and since October 2012, has traded almost without any corrections.
Comment: Finally, Mads Koefoed, Saxo Bank's Head of Macro Strategy, and Peter Garnry, Saxo's Head of Equity Strategy, use simple, yet useful models on "fair value" that indicate we are "at fair value" and that the expected return in the next six months is 0-10 percent.
Conclusion: There is a high chance that the next three to five weeks will see policymakers and central banks increase their hawkish rhetoric. I still see a very weak second half for 2014, but I am playing higher rates in this environment after a nice profit being long fixed income.
The risk is that both confidence and valuation are stretched in equities, setting off the much-needed 10 to 20 percent correction.
Safe travels,
Steen
Med venlig hilsen | Best regards
Steen Jakobsen | Chief Investment Officer
Saxo Bank A/S | Philip Heymans Allé 15 | DK-2900 Hellerup
Phone: +45 39 77 40 00 | Direct: +45 39 77 62 23 | Mobile: +45 51 54 50 00
Research: http://www.tradingfloor.com/traders/steen-jakobsen
Please visit our website at www.saxobank.com
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